This article was published by The McAlvany Intelligence Advisor on Wednesday, January 13, 2016:
Over time vultures have gotten a bad rap. Some refuse even to admit that the american Bald Eagle is a vulture, preferring to think of it as a magnificent example of strong individualism and pride. In fact they are birds of prey, scavenging the carcasses of dead animals or, in the case of the Bald eagle, swooping down to snatch an unsuspecting fish from the water with its powerful talons.
Vulture funds work in somewhat the same way. To put it crudely, they attend the funeral of a deceased company and then wait until everyone has left before resurrecting it. In the case of Marathon Asset Management, the miracle potion responsible for the resurrection is cash.
Marathon's CEO, Bruce Richards, simply couldn't be happier. Just before Christmas he predicted that not only would the price of a barrel of crude drop into the $20s but that it would also take a third of America's energy companies with it. It was more an expression of hope rather than despair.
As of last July nine oil field companies had already gone bankrupt, including Quicksilver Resources, PBZ Resources, Dune Energy, Sabine Energy, WBH Energy, and American Eagle Energy. At the time another nine were teetering on the edge.
In December many of those shuttered their operations under Chapter 11, while those surviving have cut their budgets and their staffs sharply while continuing to produce in order to service their debt loads. Three companies – Energy, Inc., Energy XXXI Ltd. and Halcon Resources – all paid out more than 40 percent of their total revenues in the third quarter last year just to service their debts.
According to three major banks – Goldman Sachs, Citigroup, and Morgan Stanley – crude prices are likely to drop into the 20s, even as Tuesday's market action showed Nymex Crude touching $30.50 intraday. Goldman's outrageous suggestion that crude could hit $20 before finding a bottom stretched the envelope of credibility at the time. But with the other two banks reiterating the same prediction on Monday, the pain in the oil patch is likely to get worse before it gets better.
But not everyone is suffering during the downturn. ConocoPhillips and Pioneer Resources hedged against lower prices in the futures market and Pioneer just offered $1.4 billion in new shares, which offering was oversubscribed.
Enough companies are continuing to produce that government officials just predicted that U.S. crude oil production will stay around 9.2 million barrels per day for the rest of the year, 1% higher than a year ago when oil was trading 40 percent higher.
Vulture funds like Marathon are waiting until the time is right. The oil belonging to failed energy companies remains in the ground, ready to be developed by newly-minted debt-free companies whose variable costs are far below current prices. Marathon will rejuvenate and resurrect them with massive but temporary insertions of fresh capital and, once up and running, they will be sold to other investors more interested in long term capital appreciation and current income than short-term but potentially risky profits.
All of which is no doubt causing increasing angst in Riyadh and elsewhere as the American oil industry continues to foil attempts to throttle it back, allowing prices to move higher. Hoping for a different outcome, OPEC and others dependent upon higher prices to close their government's deficits will have to wait a lot longer.
Sources:
Wall Street Journal: Oil Plunge Sparks Bankruptcy Concerns
Bloomberg.com: Oil Seen Heading to $20 by Morgan Stanley on Dollar Strength
OilPrice.com: Oil Bankruptcies Mark Devastating End Of The Year For U.S. Drillers
Investopedia: Oil Companies Near Bankruptcy
Background on Marathon Asset Management
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